Why Verizon Can’t Quit Yahoo

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CreditHarry Campbell

By Steven Davidoff Solomon

Dec. 20, 2016

It’s time that we stopped beating up on Yahoo.

With the recent disclosure of another hacking of Yahoo, one potentially affecting more than a billion accounts, Verizon Communications has reiterated that it might seek to renegotiate its $4.8 billion deal to acquire the beleaguered internet company. There is speculation that the company may even try to walk away from the deal.

And because this is Yahoo, market analysts and pundits have piled on. Jim Cramer of CNBC said “who can blame” Verizon for wanting to leave the deal. Shira Ovide, a Bloomberg Gadfly columnist, also seemed to endorse a Verizon exit and labeled Yahoo “the technology industry’s most hapless company.”

All of these people are buying into the easy narrative that Yahoo is a loser in the tech industry, unable to keep up with the likes of relative newcomers like Snap. Their conclusion is that Yahoo is simply getting what it deserves as its core business melts away and the company goes through one management change after another. The current chief executive, Marissa Mayer, is only the latest.

But if you dig into Yahoo’s numbers, the business, once in rapid decline, is stabilizing. There has yet to be any significant sign that this hacking or the previously announced one have materially affected Yahoo’s earnings or revenue.

Given this, it seems that talk of Verizon being able to walk away from the Yahoo deal is overblown.

Admittedly, the latest Yahoo hacking looks awful at first blush. On Dec. 14, Yahoo announced that it appeared that “an unauthorized third party” stole “user information” from one billion accounts in 2013. Less than three months earlier, on Sept. 22, Yahoo disclosed a hacking of half a billion accounts that occurred in 2014.

These are big numbers, but they should be put in perspective. At this point in history, there have been repeated digital thefts of information, including from the Democratic National Committee. It is unclear how strongly users actually react to these types of disclosures. In its third-quarter earnings release, Yahoo noted that traffic on its site was slightly up even after news of the 2014 break-in was released. It is too soon to know the effect of the December news of another hacking, but there is no reason to think it will make any difference. People simply seem immune to this news by now.

Yahoo earned $229 million in the third quarter, before income, taxes, depreciation and amortization, with revenue of $858 million (both adjusted to take into account acquisition costs and other one-time earnings.)

These numbers were hailed as pretty good, within the midrange of Yahoo’s estimates for 2016. Yahoo’s free cash flow was also $167 million, up from $18 million in the third quarter of 2015. Ms. Mayer has tried to refocus Yahoo’s business on the so-called Mavens (mobile, video, native and social). Here, the company appears to be stable. Mavens revenue has gone from almost nothing in 2012 to $385 million in the 2016 third quarter. That was down 4 percent from 2015, but largely because of declines in video with the three other segments growing modestly.

Given Yahoo’s more than one billion monthly active users and that there is so much uncertainty surrounding its business, it is hard not to view Verizon’s deal as a bargain at $4.8 billion. Snap has only 150 million active users and is being hyped as going public with a $25 billion valuation at 25 times forecast revenue (Yahoo’s buyout price is only about six times current revenue).

Even if Verizon has buyer’s remorse, it is going to have a hard time walking away from this deal as a legal matter. Under the parties’ acquisition agreement, Verizon can terminate only if there is a so-called material adverse effect to Yahoo. This is a defined term in the merger agreement that allows Verizon to quit the deal if something materially adverse happens to Yahoo and the event was not disclosed to Verizon before signing the agreement. What actually meets that definition is a legal question that would be decided by a Delaware court, which would look at whether the hacking was long term and durational. This is a high threshold. It is not a coincidence that the Delaware court has never found a material adverse effect to exist, though there is talk that the problems at Alere may be a material adverse change allowing Abbot to terminate its deal.

In the case of the Yahoo hackings, it doesn’t appear that this threshold has been met.

The actual cost of the intrusion is also unlikely to be deemed a material adverse effect by the Delaware courts because, historically, these thefts have not been that expensive for big companies.

In 2013, Target said credit card information of tens of millions of customers was stolen. That cost Target an estimated $252 million, but a tax deduction and insurance reduced that to $105 million. The related litigation by customers settled for $10 million, and lawsuits by banks and card companies affected by the breach settled for about $100 million. Sony spent $35 million to restore its systems after the hacking the following year. Other big break-ins at LinkedIn and Home Depot were even less costly relative to the billions of dollars in annual revenue these companies produce.

It is hard to see Yahoo incurring higher costs. These breaches happened more than three years ago. It is difficult to know or even trace any bad effect given the passage of time. Even if you could trace the effect, the hacked information in many cases is stale or unimportant. Yahoo said it included names, email addresses, telephone numbers, dates of birth, passwords and possibly encrypted or unencrypted security questions and answers. In the last three years, much of this information has changed, though admittedly birth dates have not.

Of course, this doesn’t mean that Verizon isn’t pursuing the possibility of using the material adverse effect clause to alter the deal terms. This is M&A Strategy 101. Verizon will most likely request as much information as possible from Yahoo to slow things down and make Yahoo nervous. According to the playbook, it will eventually claim that Yahoo is not complying with these information requests. That’s probably what is going on now behind the scenes.

If Verizon is pursuing this strategy, it is doing so to cajole Yahoo’s board into cutting $1 billion to $2 billion off the deal price just to be done with the matter. Yahoo’s market capitalization of $36.9 billion, because of its ownership of a minority stake in the Chinese e-commerce company Alibaba, makes $1 billion a rounding error.

The parties have incentives, therefore, to simply recut the deal and lower the price or have Yahoo explicitly assume the direct liabilities related to the hacking. In Yahoo’s case the biggest incentive is simply to end its long nightmare and move on.

But I’m hoping that Yahoo stays firm. Of all the internet 1.0 businesses — Lycos, Kozmo.com, broadcast.com, pets.com — Yahoo and Amazon are the only ones still standing. It is a credit to both companies, but also evidence that for all her faults, Ms. Mayer has stabilized a troubled business. And if the Yahooers actually believe this, Verizon will not have much to stand on.

If Yahoo stands firm right now and no new bad facts come out, Verizon will have to close or be forced by a court to do so. That Yahoo hasn’t already sued to force a closing shows how gun-shy the company has become.

For the rest of us, we will have to wait. In the meantime, we should change our passwords.

Steven Davidoff Solomon is a professor of law at the University of California, Berkeley. His columns can be found at nytimes.com/dealbook. Follow @stevendavidoff on Twitter.

A version of this article appears in print on , on Page B4 of the New York edition with the headline: Yahoo, Stable Despite Hacking, Is Still Worthy of Verizon Deal. Order Reprints | Today’s Paper | Subscribe